Options Basics: Premium, Intrinsic Value and Time Value

The cost of an option is knows as the premium. Let's use Apple example again. The current stock price of Apple is $199.83. The premium of AAPL Jan 2008 200 call is $9.00. The premium of AAPL Jan 2008 195 call is $11.65.

Depending on the stock price and strike price, an option may be in the money, at the money, or out of the money. For a call option, if the stock price is higher than the strike price, we say the option is in the money. For the above example, the call AAPL Jan 2008 195 is in the money since the stock price, $199.83, is higher than the strike price, $195. On the contrary, the call AAPL Jan 2008 200 is out of the money since the stock price is lower than the strike price. An option is at the money if the stock price is equal to the strike price.

The premium of an option includes two parts: intrinsic value and time value. Intrinsic value is the difference between strike price and stock price if an option is in the money. The intrinsic value is 0 if the option is out of the money or at the money. The more an option is in the money, the higher the intrinsic value. The longer the time till expiry day, the higher the time value.

Posts that discuss options basics:
What's Stock Option?
Premium, Intrinsic Value and Time Value
Option Investment, How it Works?
Why Option Investment?
What's the risk?